How to Handle a Tax Audit

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Published: May 8, 2011 4:26 a.m. ET

Last Updated: May 11, 2011 1:53 a.m. ET

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Every year, the Internal Revenue Service chooses 1% of all individual tax returns for closer examination – an audit. Technically the lucky 1% is chosen at random, though people who make more money are more likely to get audited than people who make less. But if you cooperate with the IRS and follow some basic steps the process can be relatively painless.

Respond in a timely fashion. It might seem obvious, but ignoring a notice from the IRS will not make it go away, and delaying your response allows potential penalties to add up.

Be prepared. The IRS will request the records used to prepare your return. Often, that includes receipts to prove business expenses or statements regarding investments or other income. Provide exactly what you're asked for—no more, no less.

Get help. If you don't understand what the letter is requesting, meet with a certified public accountant, enrolled agent or tax attorney who can help you interpret the notice.

Make your case. Don't assume the IRS is right.

Be open, but not too open. Many audits are handled over the mail, but sometimes you'll have to meet in person with an IRS agent. A representative, such as a CPA, attorney or enrolled agent, may help you provide the required information without disclosing too much.

Take a stand--or take the stand. If you believe you're correct regarding your reported income or claimed deductions, you have the right to defend yourself, all the way to tax court. You'll likely need an attorney if your case goes to court. The IRS offers a guide to audits explaining the procedure and possible outcomes.

Do the right things. If the IRS finds you underpaid, you'll have to file a new return and pay the taxes you owe.

Do it over. If the IRS finds you failed to report some income or are mistakenly claiming a deduction or credit you don't actually qualify for, you may have to amend your return. Be aware that the IRS may go back to previous returns if it suspects you've committed the same mistake, or fraud, in previous years.

Pay any taxes owed. There are options for paying the bill, even if you don't have the money right now. You can start an installment agreement with the IRS, put the balance on a credit card or pay the balance in full.

What not to do when facing a tax audit.

Don't keep poor records. Always hold on to any documents regarding tax deductions, taxable income and other credits. In the event of an audit, you'll need the proof to make your case.

Don't assume the matter is resolved. The audit letter may not arrive until 12 to 18 months after you file your return. And in some cases, the IRS may request additional documents or information before the discrepancy is settled.

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